What should be the amount of the sale price? PLEASE SHOW WORK BY HAND With extra

Question

What should be the amount of the sale price?

PLEASE SHOW WORK BY HAND

With extra cash from operations, Ace Auto Parts decides to buy a Savings and Loan. Ace will pay $400,000 for the S & L with the intention of selling it after five years. Ace hopes to earn a 20% rate of return. The expected inflation rate is 5%. (a) What should be the amount of the sale price, if Ace is to earn a 20% return on their investment? Exclude the effects of inflation. (b) What should be the amount of the sale price, if Ace is to earn a 20% return on their investment after considering the effects of inflation.

Explanation / Answer

Ans. Amount of Sale Price without Inflation:

A = I (1+ r) ^ t

I = Investment, r =ROR , t =Time

A = 400,000 (1+ 0.20)^ 5

A = $ 995,328

So, sale price is $ 995,328 for 20% ROR.

B. With the adjustment of Inflation:

ROR at 25%(i.e. 20+ 5)

ROR = 1+r / 1+ i - 1

r =Rate of return , i= Inflation Rate

ROR = 1+ .25 / 1+0.05 - 1 = 0.19

This is less than required ROR.

Now, if we take 26%

ROR = 1 + 0.26 / 1 + 0.05 - 1 = 0.20 OR 20%

That is equal to Required ROR

A = I (1+ r) ^ t

I = Investment, r =ROR , t =Time

A = 400,000 (1+ 0.26)^ 5

A = $ 1270318.78

So, sale price with inflation is $1270318.78

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